What is the link between financial literacy and bankruptcy?

In 2016 I interviewed 29 undischarged Australian bankrupts as part of a thesis investigating financial literacy. The aim was to discover if this accepted poor financial outcome, going bankrupt, was the result of the individual's level of financial literacy. The public policy on financial literacy education is built around the premise that financial literacy levels in Australia are low (as measured by some standard tests), therefore more education in the form of brochures, courses and websites should be delivered.

The policy makers say this increase in education initiatives will increase knowledge, and therefore consumers will avoid making poor financial outcomes such as going bankrupt or not saving for their retirement. It is easy to spot the flaws in this policy. How can you "test" financial literacy? Do people actually acknowledge and read brochures and websites? Does increased knowledge lead to a change in behaviour? Is financial literacy the sole reason for a poor financial outcome? This is why I wanted to interview bankrupts. Was their insolvency the result of them being financially illiterate? Were they greedy and reckless, shamelessly hiding assets from creditors as the public perceives most bankrupts?

What I found had two levels. First, the demographics and data collected from the bankrupts supported the publicly available data from the Australian Financial Services Authority (AFSA). Second, the reasons why the consumers became insolvent are complex, integrated and could not have been prevented by a pre-emptive financial literacy initiative such as a brochure. The majority of bankrupts are not "high-flyers" but rather are nondescript low to middle income earners with modest amounts of consumer debt and almost no assets. This confirms Australian insolvency academics Ian Ramsay and Cameron Sim's research from 2010 that personal insolvency in Australia is a "middle-class phenomena".

Gregory Mowle

The last, and only other, time someone spoke to Australian bankrupts was Martin Ryan who interviewed 77 bankrupts in Melbourne in 1986. Ryan explored a range of themes such as the effect of harassment from debt collectors, the efficacy of welfare payments and any feelings of shame or guilt that the bankrupts experienced.

To repeat Ryan’s research, in late 2015 I invited 1000 undischarged bankrupts to participate in my research about their experiences of bankruptcy. The bankrupts were recruited from the National Personal Insolvency Index (NPII), the public record of personal insolvency proceedings in Australia that is maintained by the AFSA. Invitations were sent to 1000 undischarged (current) bankrupts in November 2015. A second round of invitations was sent in mid2016 and a total of 29 bankrupts agreed to take part in taped interviews with an average interview time of 70 minutes.

Even though most of the bankruptcies were non-business related, the findings and themes that emerged from the interviews have relevance for all credit managers. First, the bankrupt’s insolvency was not caused by one single factor such as low financial literacy. Their insolvency was caused by a series of interwoven events and mishaps as well as interacting factors such as peer pressure, advertising tactics, commissiondriven loan selling, and relationship breakdown. Not every poor financial outcome, such as going bankrupt, is a result of poor financial literacy.

External factors such as a relationship breakdown, coming into contact with a salesperson incentivised to earn a bonus by selling a specific financial product, and the power of advertising mean that even the most financially literate individual may still make poor financial decisions.

A striking example from the interviews was a 40 year old low-skilled male who was on casual wages of $450 a week and sharing public housing when he went shopping for a car. He knew he should purchase a car with a price of $5000 maximum but made a life-changing decision to stop off at a new car yard to admire his “dream car” – that came with a $47,000 price tag. He had no intentions to buying when a salesperson approached him. One hour later he drove away in his dream car having been financed to repay a total of more than $70,000 over 7 years. Six months later the car was repossessed and he was presented with a $52,000 bill for the loss after auction sale. A friend told him he should go bankrupt, so he did.

If he had of sought professional advice, they would have suggested that the debt be challenged under the Responsible Lending obligations of the Credit Act. The second theme to emerge was that stress from their situation caused debtors to panic and not think clearly. This meant they chose the wrong options. These included trying to consolidate their debts (throwing new debt on top of old debt rarely addresses the underlying causes of insolvency), ignoring the problem, avoiding professionals who could assist them (financial counsellors, insolvency practitioners), and asking family and friends for financial assistance or for advice – even when they clearly don’t have the support or knowledge to assist.

I specifically asked the bankrupts who, or what, they first went to for assistance on insolvency or debt management. The majority typed in a phrase like “help with debts” on their internet search engine and then clicked on the first links that appeared. This meant debtors were contacting firms that are in the business of providing either consolidation finance or an insolvency option such as a Part IX Debt Agreement. While they are legitimate options, they were not the best options for the bankrupts at that stage of their insolvency.

What they needed was more time. Time to think of a long-term solution to their crisis such as finding employment or restructuring their business. They needed time away from the pressure of receiving communications from creditors – all requesting that their debt be repaid first. They needed time to seek out the professional and impartial advice that they needed and then digest the information they receive.

The third theme is that lack of a support network is a key factor in whether a debtor ends up bankrupt. A support network includes family and friends who can be relied upon to provide emotional support as well as referral to appropriate medical, psychological and financial services. Lastly, while the purpose of the interviews was not to forensically dissect their financial situations, objectively at least half of the bankrupts interviewed did not have to go bankrupt. This is not to say that they were to continue with the burden of their debts and struggle in financial hardship. Rather they could have accessed a range of options to assist them in the short and/or long term.

These included using the National Hardship Scheme, or utilising financial counselling agencies to access a range of options such as challenging the debt, utilising financial hardship options such as a moratorium for 90 days, or using the free and independent Ombudsman services. While the main aim of my research was to assist with the development and delivery of financial literacy initiatives by looking at their effectiveness through the lens of bankrupts, the findings have implications for all credit managers. The bankrupts all reported that they did not want to go bankrupt.

They wanted to pay their debts but could not. Most felt great shame and embarrassment at having to go bankrupt and expressed that they felt like failures. Except for one of the bankrupts that I spoke to, there was a zero return back to creditors. While credit managers need to make a quick and firm decision whether to pursue outstanding debts, they should do so from a perspective of “This debtor wants to pay, but presently cannot. What can I do to assist them in the short-term including referring them to independent professional services?”

About the Author Gregory Mowle initially worked in the finance sector across the lending, insurance and credit management fields. In 1999 he was the Dux of the Australian Institute of Credit Management’s Certified Credit Executive program.

In 1999 he took his extensive experience of consumer credit to work for Lifeline Brisbane as a financial counsellor. In 2004 he developed financial literacy programs for The Smith Family, creating partnerships with major lenders and governments for effective early intervention programs. In 2009 he joined the corporate and financial regulator, ASIC, to work as part of their consumer education team. He is currently completing a PhD at the University of Canberra where he is also a lecturer.